Stocks: Advance or Retreat?

Kiplinger's Personal Finance|July 2020

Stocks: Advance or Retreat?
Amid the market chaos, investors can gauge whether a rebound will last by looking at market breadth.
Ryan Ermey

THINGS GOT GLOOMY FOR INVESTORS FOR a while. Between February 19 and March 23, stocks in Standard & Poor’s 500-stock index took a Wile E. Coyote– style plunge, losing 33.8% in just a month. Despite uncertainty about the length and severity of the pandemicrelated shutdowns that triggered the sell-off, investors, like the coyote himself, once again grew optimistic, pushing the S&P 500 back up 28.4%. (Prices and other data are as of May 15.)

Lately, the market’s behemoths have been doing the heavy lifting. Just five stocks—Alphabet, Amazon.com, Apple, Facebook and Microsoft—account for 22% of the S&P 500 index’s market capitalization (share price times shares outstanding), a record level of dominance among a handful of companies. So far in 2020, the S&P 500’s five biggest stocks have returned 11.5%, on average. The average loss in the rest: 20.4%. “It’s okay for leaders to lead. But if the market’s generals are headed in one direction and the troops in another, then you have potential problems,” says Willie Delwiche, a strategist at investment firm Baird.

The generals-versus-troops metaphor is a common way of understanding an indicator known as market breadth, a measure of how many stocks are participating in a given market move. For investors practicing technical analysis (forecasting the direction of stock prices based on statistical patterns), understanding breadth is key to determining whether a rally in the stock market will lead to a sustained recovery or is masking further bouts of turbulence and downturns.

Making sense of the recovery. Wall Street traditionalists favor stock analysis based on fundamentals such as corporate earnings and business models. Fundamentals easily explain the precipitous drop in share prices in the wake of the COVID-19 outbreak, as government-mandated shutdowns slashed entire industries’ revenue streams to near-zero overnight.

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July 2020